Stronger manufacturing activity bodes well for economic growth but isn’t necessarily great for stock investors

By Steven Russolillo

President Donald Trump’s pledge to revitalize American manufacturing is already bearing fruit in recent factory data. Stock-market investors like that. They may be less pleased if it emboldens a faster rate-tightening cycle.More evidence of manufacturing’s latest rebound is expected Monday when the Institute for Supply Management releases its monthly report. Factory activity has expanded significantly in recent months, giving hope that the U.S. economy could also be poised for faster growth as well.Economists polled by The Wall Street Journal estimate that the ISM’s manufacturing index hit 57.5 in March, comparable to the 57.7 reading in the prior month. That would mark the seventh straight month the index has been above 50, matching the longest streak in six years. Readings above 50 imply customers’ orders and factory production are expanding..

An employee checks the tolerance of a chain during production at the Pewag manufacturing facility in Pueblo, Colo., on March 22. The Institute for Supply Management is scheduled to release manufacturing figures on Monday. Photo: Bloomberg News

ISM said last month that its index at current levels tends to correspond with an economy growing at 4.5% annually. That would be more than twice the economy’s average annual growth in the current expansion.

Diffusion surveys such as ISM’s garner attention because they usually come before government data and ask respondents about whether conditions are improving, not their absolute level. It is no coincidence then that they have surged under Mr. Trump, who has focused on reviving manufacturing employment.

But evidence of a rebound in activity was mounting before the election. Rising oil prices and stabilizing growth around the world also have contributed to the improved manufacturing conditions. And now, after waffling above and below 50 in late 2015 and early 2016, the index finds itself in rarefied territory. Over the past 30 years, the ISM indicator has been at or above 57 only 15% of the time. Just like now, almost all of those instances occurred as the Federal Reserve was raising interest rates.

Before the financial crisis, the ISM index jumped above 57 in late 2003 and stayed above it for about a year. That coincided with the start of the Fed’s tightening cycle which spanned from 2004 through 2006. The ISM index was also above 57 in late 1999, most of 1994, and a majority of 1987. Not coincidentally, all three time frames came during Fed tightening cycles.

The Fed only has raised interest rates three times since the financial crisis, including once last month. Now the debate centers on whether the central bank will hike rates either two or three more times over the course of the year.

Stock investors cheering the bounce in manufacturing sentiment need to recognize that every action has a reaction. Higher rates usually aren’t a reason to celebrate.

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